RRSP overcontributions — ignorance isn’t bliss

News & Views

Can you contribute more than your RRSP limit?

Contributions to your own registered retirement savings plan (RRSP), pooled registered pension plan (PRPP), and your spouse or common-law partner’s RRSP all count against your individual contribution limit. Generally, when your RRSP contributions exceed your limit plus $2,000, you have to pay a tax of 1% every month that these excess contributions remain in your RRSP. The Minister of National Revenue can, at their discretion, waive the tax on the RRSP overcontribution. This discretion can be used if the taxpayer can demonstrate that the overcontribution was the consequence of a reasonable error and reasonable steps are being taken to eliminate the overcontribution. This begs the question, what’s reasonable? The following case helps answer this question.

Case study: What could happen if you contribute more than your RRSP limit?

In a recent court case, Froehling v. Canada (Attorney General) (this decision is available in English only), Mr. Froehling overcontributed to his RRSP and his wife’s spousal RRSP and was assessed a tax on the excess contribution of $1,008.25 (known as Part X.1 tax in the Income Tax Act (ITA)). He paid this amount in full in March 2019, then paid the interest of $32.28 on that amount in August 2019. He asked the Minister to use their discretion and waive the tax. The Minister refused.

In multiple letters to the Minister, Mr. Froehling outlined his rationale for the waiver of the tax on his overcontribution. It started with his wife receiving an inheritance and their desire to fully contribute to their RRSPs. He also misunderstood how RRSP contribution limits worked (he believed that he and his wife’s contribution room could be combined).

The Minister denied his waiver request multiple times in writing, stating that subsection 204.1(4) of the ITA allows the Minister to use discretion to cancel or waive Part X.1 tax if the excess contributions were related to a reasonable error and the taxpayer takes reasonable steps to remove the excess. The Minister also explained that misunderstanding your RRSP limit or the rules and regulations about RRSP contributions doesn’t constitute a reasonable error. Mr. Froehling had been making RRSP and spousal RRSP contributions since 2010. Given this history, the Minister stated that he should’ve known his contribution limits. While he may have taken reasonable steps to eliminate the excess contribution, this alone wasn’t enough to get a waiver of the tax by the Minister.

Mr. Froehling tried his luck one more time and sought a judicial review. He argued, amongst other things, that his reasonable error was a misunderstanding of how spousal RRSPs worked, believing that contributions he made to his wife’s spousal RRSP were calculated against her personal RRSP limit and that’s why he over-contributed to his RRSP.

The key question in the court’s opinion: what’s a reasonable error?

In her analysis, Justice Aylen stated that a taxpayer seeking a waiver of Part X.1 tax must establish to the satisfaction of the Minister that:

(a)   the excess amount or cumulative excess amount on which tax is based arose as a consequence of reasonable error

(b)   reasonable steps are being taken to eliminate the excess.

In applying subsection 204.1(4), “it is important to underscore that, because the Canadian tax system is based on self-assessment, it is incumbent on taxpayers to take reasonable steps to comply with the ITA, including by seeking advice where necessary [ … ] Given this obligation, it is difficult to see how a taxpayer’s ignorance about the fact that RRSP contributions are subject to a limit could be considered reasonable. By contrast, being misinformed about the contribution limit after making reasonable inquiries might well constitute a reasonable error. Likewise, the mere fact that a taxpayer has relied on an expert third party for advice is not determinative. Rather, the circumstances of such reliance need to be analyzed to determine if it was reasonable. Thus, reliance on a third party, such as an accountant, in and of itself, neither entitles nor disentitles a taxpayer to relief.”

There can be penalties for overcontributing to RRSPs

A taxpayer simply not knowing the rules isn’t enough to meet the reasonableness requirement for a waiver of the tax in this situation. The taxpayer would need to demonstrate how they came to be mistaken in assessing their available contribution room. They could refer to past notice of assessments, seek advice from a third party (such as contacting the Canada Revenue Agency directly), or consulting with a tax preparer, bank, or even an employer. Since the taxpayer was simply claiming ignorance without evidence of a process he used to formulate his understanding of how contribution limits worked, the judge found he didn’t meet the reasonableness needed for the Minister to waive the tax on his excess contribution. To make matters worse, Mr. Froehling was ordered pay the Minister’s costs in the amount of $1,000.

The Froehling v. Canada (Attorney General) case reinforces the value of advice and reminds us that ignorance isn’t an excuse when it comes to our taxes. Within our areas of expertise, our advice can be valuable for helping our clients meet many financial objectives, including their tax filing obligations. Equally important is when questions fall outside our expertise, we point clients in the right direction, whether that be another professional or even the Canada Revenue Agency directly. Sometimes putting clients on the path towards a solution is as good as providing it directly. In this case, a little research or asking the right questions could’ve provided a much less costly way to a lesson learned.

The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.

Tax, Retirement & Estate Planning Services Team

Tax, Retirement & Estate Planning Services Team

Manulife Investment Management

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